The Inner Workings of Credit Card Processing Rates

The credit card processing fee is the cost merchants are charged to process credit card payments – which sounds obvious, but there’s a lot more to them than meets the eye. If you’re not careful, your business could wind up spending thousands of dollars on processing fees. Here’s what you need to know about the basics of credit card processing fees.

What is the credit card payment process?

The customer makes a purchase from the merchant using their credit card. The merchant runs the sale through the payment gateway, which sends the credit card payment to the credit card processor. The credit card processor submits the payment to the credit card association and then finally to the credit card issuing bank. These are the parties involved in the whole process:

Merchant account provider: This is the company that manages the actual credit card processing, usually with the help of an acquiring bank. The merchant account provider’s role usually overlaps with the credit card processor.

Payment gateway: This is the portal that routes transactions to the credit card processor, usually for online shopping carts.

Credit card processor: Also known as acquiring banks, the processor acts as the go-between for the merchants and credit card associations and passes information and authorization requests to the merchants to complete their business transactions.

Credit card association: This is the company that sets the rules for the credit card payment process and also creates credit cards, such as Visa, Mastercard and American Express. Some credit card associations also function as issuing banks by developing and issuing their own cards, such as Discover and American Express.

Credit card issuing bank: This is the financial institution that issues the credit cards, such as Chase, Wells Fargo and Citi.

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How do credit card processing fees work?

Credit card processing fees, or qualified merchant discount rates, are the fees merchants pay for each credit or debit card sale. This fee is determined by your merchant account provider and has three components: interchange fees, assessment or service fees, and payment processor’s or markup fees.

Interchange fees

For each credit or debit card transaction, the card issuer charges the merchant a commission to be able to accept credit cards as a form of payment – usually a percentage of the transaction plus a flat-rate fee. This is called the interchange fee, and it’s the largest component of credit card processing fees. Interchange fees are set by each issuing bank, helping it cover potential risks associated with the sale, such as fraud, handling costs and actually approving the sale. Factors that affect interchange fees include the payment processing method, the type of card used as payment (reward, business, consumer, EMV chip, etc.) and your type of business. Visa’s and Mastercard’s interchange rates, which change twice per year in April and October, are listed on their sites.

Mobile wallets and EMV chip cards

In recent years, credit card payment options have evolved from just debit and credit cards to include mobile wallets and EMV chip cards. Mobile wallets, as the name suggests, are digital versions of a physical wallet. While there are variations on the kinds of information they can hold, most mobile wallets are equipped to hold the digital information for credit and debit cards, coupons, store rewards and loyalty cards, and personal identification.

There are multiple benefits to businesses of all sizes accepting mobile wallets as a viable form of payment. One benefit is decreased fraud, since it’s more difficult to steal the digital information from mobile wallets. Also, the processing fees for mobile wallets are expected to decrease over time.

While EMV chip cards are increasingly common, the United States was the last major market to migrate from cards with magnetic strips to EMV chip cards, which can be identified by the embedded chip. The chip acts as a miniature computer that holds the debit or credit card information. The chip is harder to replicate than a magnetic strip because it creates a unique impression every time the card is used.

Assessment or service fees

Assessment or service fees cover the credit card association’s operating cost of managing its network. These fees differ from the interchange fees in that they’re based on the merchant’s total monthly sales rather than individual transactions. While they’re typically lower than interchange fees, the assessment fees vary by network and certain specifics, such as if the card used was credit or debit, transaction volume, and if any international transactions were processed. Similar to interchange fees, assessment fees are reviewed twice per year – check your credit card statement to see the changes to your assessment fee.

Payment processor’s or markup fees

The payment processor’s or markup fee is what the merchant pays the credit card processor to use its product. These are either flat-rate fees, interchange-plus fees or tiered fees, and they are the only fees that the merchant can negotiate. With flat-rate fees, merchants pay a flat rate for every transaction to cover the interchange and assessment fee. For interchange-plus fees, your payment processor adds a fixed markup to the interchange fee (hence the name “interchange plus”). With tiered fees, the payment processor categorizes fees into one of three buckets: qualified, mid-qualified and non-qualified. Qualified means your business is qualified for credit card swipes, mid-qualified means your business is set up for key-entered transactions and for accepting some specialty cards, and non-qualified means your business is set up for all other transactions, including online sales.

Clear as mud, right? In case you’d like a visual depiction of some of this information, here’s an infographic to help you keep everything straight.

Do you need a merchant account to be able to accept credit cards?

You don’t actually need a merchant account with a merchant service provider to accept credit cards as a payment option. Signing up for a merchant account requires you to complete an application and await approval from the merchant service provider’s underwriting team. It can be a time-consuming and potentially frustrating process. Instead, small businesses or startups with few items to sell can accept credit and debit card payments via payment facilitator, or PayFac. A PayFac, such as Square or PayPal, is a merchant account that serves multiple merchants so that each merchant doesn’t need their own merchant identification number.

PayFacs are very quick and easy to set up, and merchants often receive instant approval on their accounts. Because PayFac transactions are part of a shared merchant account rather than an individual account, fees are usually set at a flat rate, so merchants pay the same transaction fee – a percentage of the total transaction amount charged – for each sale regardless of how many they process. This may be fine for small businesses, but as their number of transactions increases, it may be more beneficial to apply for a merchant account. A merchant account gives businesses the opportunity to select from a variety of flexible-rate plans that reward higher transactions with additional savings.

However, if your business is thinking of canceling its merchant account before the end of your merchant processing contract, beware of early termination fees. There are two types of termination fees: flat cancellation fees and liquidation damages. With a flat cancellation fee, businesses are charged a flat, pre-negotiated sum to cancel their merchant account. While there is no standard flat cancellation fee, they usually start at a few hundred dollars. Liquidation damages are much more expensive. With liquidation damages, you are charged the amount the processor determines it will potentially lose in revenue due to your account closing. For example, if you have a five-year contract and you decide to close your account after two years, you could pay a cancellation fee equal to three years’ worth of credit card processing fees.